Chapter Two - Wiley

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8956d_ch02_066 8/20/03 12:55 PM Page 66 mac76 mac76:385_reb: 66 CHAPTER 2 A Further Look at Financial Statements From 2000 to 2001, Best Buy’s earnings per share increased. Its priceearnings ratio decreased. This decrease might reflect a belief that Best Buy’s profitability and growth will not continue. As noted, earnings per share cannot be meaningfully compared across companies. Price-earnings ratios, however, can be compared. Illustration 2-14 lists five companies and their earnings per share and price-earnings ratios for 2001 (calculated at the end of each company’s fiscal year). Note the difference in priceearnings ratios between Sears and Intel. Illustration 2-14 Variability of earnings performance ratios among companies Company Earnings Per Share Price-Earnings Ratio Intel $0.19 169.7 Microsoft 1.45 47.8 General Motors 1.79 27.5 Kellogg 1.19 25.4 Sears, Roebuck 2.25 21.3 Business Insight INTERNATIONAL PERSPECTIVE The French know a lot about food and wine—but stocks are another matter. One observer went so far as to state, “Indeed, until recently the French widely derided people who invested in stocks as Anglo-Saxon speculators, greedy capitalists who deviously manipulated financial markets to line their pockets.” But when stock markets (or as the French say, les Bourses) around the world hit record highs, many French began taking classes to learn more about how to invest. Many have a lot to learn. For example, Jacques Giraudou decided to take a class after he sustained a huge investment loss. He had purchased an investment in the Eurotunnel, which proceeded to lose 70% of its value over a two-year period. Only after two years did he realize that he had purchased stocks rather than bonds. SOURCE: Suzanne McGee, “The French Try to Demystify Investing,” Wall Street Journal (May 27, 1999), p. C1. DECISION TOOLKIT Decision Info Needed Tool to Use for Decision How to Evaluate Checkpoints for Decision Results How does the company’s earnings performance compare with that of previous years? Net income available to common shareholders and average common shares outstanding Earnings Net income Preferred stock dividends per share Average common shares outstanding A higher measure suggests improved performance, although the number is subject to manipulation. Values should not be compared across companies. How does the market perceive the company’s prospects for future earnings? Earnings per share and market price per share Price-earnings ratio Stock price per share Earnings per share A high ratio suggests the market has favorable expectations, although it also may suggest stock is overpriced.
8956d_ch02_067 7/21/03 6:58 AM Page 67 mac76 mac76:385_reb: Using the Financial Statements 67 USING THE STATEMENT OF STOCKHOLDERS’ EQUITY As discussed in <strong>Chapter</strong> 1, the retained earnings statement describes the changes in retained earnings during the year. This statement adds net income and then subtracts dividends from the beginning retained earnings to arrive at ending retained earnings. Recall, however, that stockholders’ equity is comprised of two parts: retained earnings and common stock. Therefore, the stockholders’ equity of most companies is affected by factors other than just changes in retained earnings. For example, the company may issue or retire shares of common stock. Most companies, therefore, use what is called a statement of stockholders’ equity, rather than a retained earnings statement, so that they can report all changes in stockholders’ equity accounts. Illustration 2-15 is a simplified statement of stockholders’ equity for Best Buy. STUDY OBJECTIVE 6 Explain the relationship between a retained earnings statement and a statement of stockholders’ equity. BEST BUY CO., INC. Statement of Stockholders’ Equity (in thousands) Illustration 2-15 Best Buy’s statement of stockholders’ equity Common Retained Stock Earnings Balances at March 2, 1998 $270,607 $ 265,105 Issuance of common stock 281,951 Net income 216,282 Balances at February 27, 1999 552,558 481,387 Repurchase of common stock (285,030) Net income 347,070 Balances at February 26, 2000 267,528 828,457 Issuance of common stock 330,104 Net income 395,839 Balances at March 3, 2001 $597,632 $1,224,296 One observation that can be made from this financial statement is that Best Buy’s common stock increased as the result of transactions in the company’s own stock during this three-year period. Another observation from this financial statement is that Best Buy paid no dividends during the last three years. You might wonder why Best Buy paid no dividends during years when it was profitable. In fact, recently two Best Buy shareholders discussed this question about Best Buy’s dividend policy on an investor bulletin board. Here are excerpts: From “Katwoman”: “Best Buy has a nice price increase. Earnings are on the way up. But why no dividends?” From “AngryCandy”: “I guess they feel they can make better use of the money by investing back in the business. They still view Best Buy as a rapidly growing company and would prefer to invest in expanding the infrastructure (building new stores, advertising, etc.) than in paying out dividends. . . . If Best Buy gets to the stage of ‘stable, big company’ with little room for expansion, then I’m sure you’ll see them elect to pay out a dividend.” AngryCandy’s response is an excellent explanation of the thought process that management goes through in deciding whether to pay a dividend. Management must evaluate what its cash needs are. If it has uses for cash that will increase the value of the company (for example, building a new, centralized warehouse), then it should retain cash in the company. However, if it has more cash than it has valuable opportunities, then it should distribute its excess cash as a dividend.
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Chapter Two - Wiley

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